In this article, I’ll start with the three types of variable compensation plans. These are commission, bonuses, and sales incentives. Next, I’ll list the advantages and limitations of variable pay plans. These include complexity, reduced profitability, and workplace toxicity.
Imagine living on a remote island and leaving is not an option. You can go to one restaurant and eat the only dish they serve. Pasta!
Since it's the only source of food, you go there every day. But eventually, you get bored of it and eating becomes a chore.
Then, one day, the restaurant introduces two new items: pizza and garlic bread.
You’re ecstatic. Eating has become fun again!
Companies that rely solely on fixed salaries to motivate employees run the risk of becoming like the first version of the restaurant: a place where people go because they have to, not because they want to.
If you want your employees to enjoy coming to work every day, you have to spice things up. Offer them more than just a fixed salary to strive for.
How can you do that?
Three words: Variable compensation plans!
In this article, I’ll discuss the three most common types of variable compensation plans, as well as the benefits and limitations of implementing these plans.
Let's get started.
Types of variable pay for sales teams
Variable compensation is an additional amount given on top of an employee’s base salary. It’s usually tied to specific goals and targets.
When it comes to variable pay, you can consider many options when creating your compensation plan. Here’s a handpicked list of 15 variable compensation programs:
1. Commission
A commission is a portion of revenue given to someone who helped generate that revenue. This someone is almost always from the sales team.
For example, if John closes a deal worth $10,000 and his commission rate is 10%, then John’s commission will be $1,000 on that deal.
Interesting read: Why is sales commission a variable cost and not fixed?
A. Tiered commission
Tiered or ramped commission offers sales reps incrementally higher commission rates for exceeding the set sales quotas.
Tiered commission structure motivates sales representatives to sell more by providing higher commission rates for surpassing sales quotas.
Here’s an example of a tiered commission plan:
For sales rep A, their commission is divided into tiers. They stand to earn a 6% commission on sales made up to $50,000, 8% for sales over $50,000, and 10% on over $80,000.
Now you might be wondering how much increment you should offer for the second tier and if you should put a cap on the total commission.
Typically, companies keep a starting threshold of 0% for the first quarter. And the threshold could be anywhere from 0% to 30%. Moreover, this can vary based on the industry you’re in. For instance, SaaS can have higher tiers up to 20%, and the service industry can cap out at 6%.
Also, you should consider whether you want to cap the commission. To make this decision, weigh things like sales maturity, the likelihood of huge deals, profitability on large contracts, etc.
B. Flat rate
The flat rate commission refers to a simple and predictable commission structure where you pay a fixed commission rate to the income producers for every dollar they sell. This commission structure has no threshold and caps and typically doesn’t have a base salary.
Who are income producers?
Income producers sell commodities that generate business revenue. Real-estate agents, currency and bond traders, and insurance agents are examples of income producers.
So, if an income producer’s flat rate commission is 7%, they’ll be paid 7% for all their sales in a specific period. It can also be a particular amount — for example, a $15 commission for every unit sold.
C. Set rate
Also known as the absolute commission plan, you pay for reps upon hitting certain targets.
This commission structure is mostly used for SDRs (sales development representatives). So, their set rate commission could be something like this: Each rep will earn $100 for every lead they get.
The upside here is that:
- It’s easy to understand.
- The output is directly tied to salary.
- You don’t need to set a quota.
However, you need to keep in mind that certain reps could get more opportunities due to their skill or simply market availability – but in the end, everyone would be treated the same way. This can lead to disputes.
2. Bonus
Unlike commissions that are mostly given to sales reps and can vary based on revenue, bonuses are lump-sum payments awarded to employees from any team and for any reason.
Another aspect that sets bonuses apart is that when an employee leaves a company, their employer is not obligated to pay the owed bonus.
Let’s look at some common types of bonuses:
A. Profit-sharing
As the name suggests, profit-sharing is when a company shares some of its profits with its employees through bonuses. The higher the profits, the larger the bonuses tend to be.
Profit-sharing bonuses are usually given once a year — assuming, of course, the company had a profitable twelve months before that.
Examples of profit-sharing bonuses include:
- A manufacturing firm announcing a $2,000 bonus for all employees at the end of a good year.
- A retail store awarding a fixed rate bonus to each employee, to be calculated at 10% of their base salary.
Note: Individual performances are not considered in profit-sharing plans.
B. Spot bonus
Spot bonuses are given to employees for outstanding performance or for achieving a milestone in a particular role or task. This bonus is a small amount and is given based on merit or key performance indicators.
C. Referral bonus
Referral bonuses are given to employees who refer applicants that are successfully hired and spend a certain amount of time with the firm.
Like other bonuses, a referral bonus can depend on specific conditions like:
- What type of role is being referred to?
- How long has the referred candidate been at the company?
- What role does the employee submitting the referral have?
D. Retention bonus
Retention bonuses are used to incentivize those employees who want to quit to stay back at the firm. They are more common in larger companies.
The average retention bonus is 10-15% of an employee's base salary, but the amount can go up to 25%.
E. Signing bonus
Signing or sign-on bonuses are offered to new employees as an incentive to join the firm.
This bonus can be given as:
- A single payment.
- Multiple payments over a set period.
- Stock options.
F. Project bonus
Project bonuses are given to teams or individuals that complete a project, usually within the stipulated budget and timeframe.
This bonus is typically a cash prize and is given to the team or individual as a one-time payment.
H. Management bonus
Management bonuses are bonuses meant for director-level roles and above.
So, the total target cash compensation (TTCC) or potential total earnings is the sum of the target base salary and target bonus.
This target bonus is a percentage of the base salary and varies from 10% to 100% of the base salary.
How is the percentage decided, then?
It depends on the level of the role. The rule of thumb is the higher the position, the higher the target bonus percentage.
Additionally, most management bonus plans don't have any restrictions on the number of people who receive a payout. However, most plans cap the upside incentive payout.
3. Sales Incentives
Sales Incentive plans have the highest element of variable pay and up to 50% TTCC to sales performance. These are used to promote certain sales behaviors, and sales reps are rewarded for them.
Let’s look at the four types of incentives:
A. Sales Program Incentive Funds (SPIFFs)
Spiff is a short-term incentive used by companies to motivate their reps.
Let’s say you want more leads in the pipeline; then you can create a Spiff “If a rep produces X number of leads in Y time frame, then they’ll be rewarded with Z amount of money.”
Notice how this was created spontaneously and not planned ahead of time?
*nods vigorously*
That’s what it boils down to; if you want to spiff something up, use Spiff.
So when should you use Spiffs?
- To accelerate the sales pipeline.
- To support a product or service release.
- To discover new market opportunities.
- To boost employee performance.
However, while it creates a possibility for short-term benefits, it’s not guaranteed that it will generate desired results.
Note: While Spiffs are mostly monetary incentives, they can also be in the form of leaves, recognition, or prizes.
B. Gainsharing
Gainsharing is a type of variable compensation where employees are offered financial incentives to increase company productivity.
This productivity could be in one or multiple areas, such as:
- Higher revenues.
- Increased output.
- Fewer errors.
- Better customer service.
- Quicker production times.
Gainsharing bonuses are often paid out monthly since it allows managers to monitor team progress more frequently and make any changes to the plan if needed.
C. Management by Objectives (MBO)
Management by objectives (MBO) in sales is where managers have one-on-one sessions with their employees to set performance goals.
These goals are then listed in each employee’s MBO plan, and commissions are calculated based on how well employees achieve their objectives.
MBO is an effective strategy because you involve the employee in the goal-setting process, thereby instilling a greater sense of purpose within them.
That said, this strategy only works if your employees’ individual goals align with your business goals.
D. Add-on programs
Add-on programs offer a certain percentage of base salary when a sales rep achieves a pre-set goal. Typically, these percentages lie between 5-10%.
While these plans target specific work units, roles, or employees, they can be permanent and ongoing.
The top X most productive reps will receive X percent of their base salary is an example of an ongoing add-on plan.
Four key benefits of variable compensation plans
Let’s look at the four main benefits of variable compensation plans:
1. Increased productivity
A well-executed variable compensation plan will always push your employees to work harder because they have much to gain.
Consequently, you reap the benefits of higher workforce productivity — be it in terms of more revenue, improved customer experience, better products, etc.
2. Better employee retention
If your variable pay plan is lucrative yet achievable, your more talented employees will probably be coining it in. This will make them likelier to stick around.
In exchange, you get to build a more robust and agile workforce that is loyal, hardworking and helps you make good on your business plans.
3. Planning and administrative flexibility
The beauty of variable compensation is, well, its variable nature. You can choose any plan you like, run it for as long as you need, and make changes as often as you want (all the while keeping your employees in the loop, of course).
For example, if you want to pay the variable component only after the money comes in, you could choose a plan that ties commissions to collections instead of revenue.
Or, if money is tight and you want to motivate your staff with minimal investment, you could opt for one of the non-monetary reward ideas in the previous section.
4. Aligned employee and employer goals
Variable compensation is your best bet for aligning employee efforts with company objectives. All you have to do is design a plan that drives the right behaviors.
Needless to say, this helps you stay competitive in a global marketplace that’s becoming increasingly unforgiving with each passing day.
Three common limitations of variable compensation plans
Variable compensation plans have a few limitations, too. Let’s see what they are:
1. Complexity
I won’t lie — some variable pay plans can get complex.
Take tiered commissions, for instance, which I mentioned at the start of this article.
Setting different commission rates for different quotas makes calculations tricky enough. If you add things like roll-ups and clawbacks on top of that, your payroll is going to have a field day.
Unless, of course, you have solid systems in place!
The more complex your variable compensation plan, the more straightforward your setup ought to be. Fewer moving parts make for a more cohesive work engine.
2. Reduced profitability
While variable compensation plans help you stay competitive, the payouts can hurt your bottom line if you don’t execute the plan well.
For example, if you don’t factor in market trends or seasonal changes into your plan, you could end up paying your reps massive commissions that weren’t exactly earned.
3. Toxic work culture
Variable pay plans that aren’t planned or managed well can lead to a seriously toxic work environment.
For instance, sales reps might refuse to share tools or critical information with other representatives for fear of losing out on commission. Or if your targets are too high and only a few employees are hitting them, the rest of the team might become bitter and bad-tempered.
Use a commission software for variable pay calculation.
Sales commission software helps you automate variable pay calculation. With ElevateHQ you can integrate with your current tools, such as CRM and spreadsheet to pull rep and deal data. You can add different plans and write commission logic to automate calculations.
This way, you can also ensure transparency with your reps. They can also ask queries from within the platform.
